Is the forgiveness of debt associated with a short sale exempt if you haven't lived in the short sale property for two years? The short sale property has been vacant, for sale for the past two years. Previous to that is was a primary residence for eight years.

To qualify for the exemption, you must have lived in the home as your primary residence for at least two of the last five years before the sale. To meet this test, the years do not have to be consecutive. Debt forgiven on your primary residence is tax exempt, but you may have to file a form 982 with your tax return. If you plan to take advantage of the Mortgage Debt Relief Act, report the amount of debt forgiven on IRS Form 982 and attach it to your income taxes for the year in which the debt was forgiven.Ordinarily any debt forgiven is treated as income reported on line 21 of 1040. The Mortgage Forgiveness Debt Relief Act of 2007 makes the debt forgiven on your primary residence non-taxable through 2012. The 2007 Act generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualify for this relief.This provision applies to debt forgiven in calendar years 2007 through 2012. The law was passed to help struggling homeowners get through the collapse of the housing boom, but it will expire after 2012 unless Congress renews it.Up to $2 M of forgiven debt is eligible for this exclusion ($1M if married filing separately). The exclusion doesn’t apply if the discharge is due to services performed for the lender or any other reason not directly related to a decline in the home’s value or the taxpayer’s financial condition.The amount excluded reduces the taxpayer’s cost basis in the home.